The  Business  Side  of  Holding 
Out  Income  Tax  on 
Coupons,  Etc. 


Report  of 

Trust  Companies  Committee 


7b 


Trust  Companies  Committee. 

To  the  Trust  Companies  of  New  York  City  : 

The  undersigned  Committee,  appointed  on  March  21, 
1913,  to  urge  upon  the  Committees  of  Congress  having 
charge  of  the  proposed  taxation  of  incomes  certain 
features  with  respect  to  the  collection  of  taxes  under  the 
Act,  begs  leave  to  submit  the  following  report : 

Since  the  date  of  the  organization  of  the  Committee, 
it  has,  with  the  assistance  of  its  accountant  and  its 
counsel,  endeavored  to  bring  to  the  attention  of  the 
Committees  of  Finance  in  the  United  States  Senate  and 
to  the  Conference  Committee  of  the  Senate  and  House, 
to  the  members  of  the  Committee  on  Ways  and  Means  of 
the  House  that  had  particular  charge  of  the  Income  Tax 
Law,  certain  recommendations  with  respect  to  the  ad- 
ministrative features  of  the  Bill.  The  Committee  pre- 
pared a printed  brief  on  behalf  of  the  Trust  Companies, 
a copy  of  which  you  have  no  doubt  received. 

It  is  impossible,  within  the  confines  of  a communica- 
tion of  this  character,  to  enumerate  the  many  provisions 
to  which  this  Committee  called  the  attention  of  the 
Committees  of  Congress,  but  the  principal  amendment 
urged  by  this  Committee  was  the  adoption  of  the  infor- 
mation at  the  source,”  in  lieu  of  “stoppage  at  the 
source,”  as  provided  in  the  Bill.  In  this  respect  the 
Committee  was  unsuccessful  in  its  efforts  before  the 
Conference  Committee,  although  individual  members  of 
both  the  House  and  the  Senate  expressed  themselves 
strongly  as  believing  that  the  system  advocated  by  the 
Committee  was  preferable  to  that  contained  in  the  Bill. 

In  the  original  draft  of  the  bill  the  provision  relating 
to  the  stoppage  of  corporate  interest  covered  “bonds, 
mortgages  and  other  indebtedness”  of  corporations. 
This  would  obviously  have  included  among  many  other 
matters,  the  thousands  of  deposit  accounts  in  all  the 
banks  of  the  country.  Your  committee  made  an  espe- 
cially serious  effort  to  have  this  clause  more  clearly 


1 


defined,  and  the  Senate  committee  changed  the  passage 
so  that  it  now  reads  “bonds  and  mortgages  or  deeds  of 
trust  and  other  similar  obligations” — a very  much  more 
restricted  category  and  apparently  what  was  actually 
originally  intended. 

When  the  bill  was  in  the  Senate  that  body  inserted  an 
amendment  taxing  non-resident  foreigners.  This  taxing 
would  have  been  unfortunate,  as  this  country  is  a bor- 
rowing nation,  and  the  investment  of  foreign  capital  for 
the  development  of  the  country  should  be  encouraged  as 
much  as  possible.  Your  Committee  made  strong  repre- 
sentations on  this  subject,  and  Congress  was  apparently 
impressed  with  the  wisdom  of  this  policy  and  the  Senate 
amendment  was  stricken  out. 

Since  the  passage  of  the  law  the  Committee  has  been 
giving  attention  and  study  to  the  effect  the  law  and  the 
Treasury  Department  regulations  will  have  on  trust 
companies  and  general  business.  You  have  probably 
seen  the  regulations  just  issued  by  the  Treasury  Depart- 
ment, respecting  the  deduction  of  the  tax  on  bond  in- 
terest which  presented  one  of  the  most  complicated 
phases  of  the  whole  matter,  and  there  is  also  sent  you 
herewith  a statement  prepared  by  Mr.  Stuart  H.  Pat- 
terson, the  expert  employed  by  your  Committee,  explain- 
ing the  business  side  of  the  regulations  issued. 

Your  Committee  believes  that  these  regulations  are  in 
the  main  satisfactory,  and  in  certain  respects  accom- 
plish what  the  Committee  believe  should  be  inserted  in 
the  bill.  The  requirement  that  the  certificates  of  part- 
nership shall  show  the  respective  interest  of  each  part- 
ner in  the  bonds  we,  however,  believe  to  be  impractica- 
ble and  unnecessary,  as  under  the  law  the  authorities 
can  secure  a statement  of  profits,  etc.,  from  every  part- 
nership and  this  information  could  be  secured  at  such 
time  and  make  unnecessary  a repetition  of  it  on  tens  of 
thousands  of  certificates  of  ownership. 

The  Committee  will  be  glad  to  answer,  as  far  as  possi- 
ble from  its  study  of  the  Bill  and  regulations,  any  in- 
quiries that  may  be  put  to  it  and  will  be  glad  to  obtain 
an  opinion  of  counsel  or  accountants  of  the  Committee, 


upon  questions  suggested  by  a Trust  Company  member. 

Further  reports  if  deemed  necessary  will  be  made  to 
you  from  time  to  time  as  additional  regulations  are  is- 
sued respecting  rents  and  other  matters. 

Respectfully  submitted, 

Alexander  J.  Hemphill, 

Chairman , 

William  B.  Cardozo, 

Otto  T.  Bannard, 

Edward  O.  Stanley, 
Calvert  Brewer, 

New  York,  October  27,  1913.  Committee. 


Business  Side  of  Holding  Out  Income  Tax  on 
Coupons* 

By  STUART  H.  PATTERSON 

The  Treasury  Department  regulations  just  issued 
relative  to  holding  out  the  tax  on  bond  interest,  are  clear 
as  to  what  shall  be  done  from  the  Government’s  point  of 
view,  but  an  outline  of  the  effect  the  regulations  will 
have  on  business  conditions  may  be  helpful  to  banks, 
trust  companies  and  corporations,  and  assist  the  Gov- 
ernment in  putting  the  law  into  operation  with  the  least 
possible  disturbance  to  established  business  conditions. 

The  law  provides  the  tax  on  bond  interest  shall  be 
collected  at  the  source,  but  as  anyone  who  has  read  the 
act  is  aware,  the  law  fails  to  define  the  source,  so  that 
without  specific  instructions,  any  one  of  ten  or  fifteen 
banks  through  which  the  coupons  pass  might  feel  that 
in  each  instance  they  would  be  held  responsible  for  the 
collection  of  the  tax  and  consequently  in  order  to  pro- 
tect themselves,  each  might  hold  out  the  tax.  Under  the 
Treasury  Regulations  the  source  is  clearly  defined,  gnd 
for  all  interest  on  the  obligations  of  domestic  corpora- 
tions the  debtor  corporation  (issuing  company)  or  its 
paying  agent  (if  designated  pursuant  to  the  regula- 
tions), is  the  source,  except  where  the  bondholder  fails 
to  identify  the  class  to  which  he  belongs,  by  attaching 
an  Ownership  Certificate  to  his  coupons.  In  this  latter 
case  the  first  person,  bank  or  trust  company  purchasing 
the  coupons  or  receiving  them  for  collection,  becomes  the 
source  and  attaches  to  the  coupons  the  name  of  the  per- 
son from  whom  the  coupons  were  received  so  that  the 
Government  will  ultimately  have  a definite  record  of 
those  from  whom  the  tax  has  been  withheld.  The  Col- 
lecting Bank  also  withholds  the  tax  out  of  the  proceeds 
of  the  coupons. 

Where  income  is  from  foreign  countries,  in  every  case 

* This  statement  relates  to  the  methods  prescribed  for  November  1st  and  thereafter. 
For  special  instructions  from  date  to  November  15th  see  bottom  of  page  11. 

4 


the  first  person,  bank  or  trust  company  receiving  the 
items,  is  the  source. 

The  bondholders  as  mentioned  in  the  regulations  can 
be  grouped  into  four  classes : 

1.  Citizens  of  the  United  States  or  resident  foreign- 
ers, who  are  exempt  from  taxation  because  their  net 
income  is  less  than  $3,000  or  $4,000,  according  to  status 
of  single  or  married. 

2.  Citizens  of  the  United  States  or  resident  foreign- 
ers, whose  net  income  is  in  excess  of  $3,000  or  $4,000,  but 
who  are  allowed  exemptions  up  to  a point  of  $3,000  or 
$4,000,  according  to  status. 

3.  Corporations,  joint  stock  companies,  associations, 
etc.,  as  fully  described  in  paragraph  G of  the  income 
tax  law.  With  respect  to  such  organizations  the  law 
provides  the  tax  shall  not  be  withheld  at  the  source  irre- 
spective of  whether  or  not  the  income  is  taxable. 

4.  Non-resident  foreigners. 

It  will  be  seen  from  the  above,  that  to  carry  out  the 
provisions  of  the  law,  of  holding  out  the  tax  only  on  a 
certain  class  of  interest,  it  becomes  necessary  to  identify 
the  coupons  with  the  owner  of  the  bonds  and  ascertain 
the  class  to  which  the  owner  belongs,  which  can  only  be 
done  when  coupons  are  presented  for  payment,  because 
when  once  paid  coupons  lose  their  identity. 

Many  debtor  corporations  are  also  interested  in  this 
classification  for  the  reason  that  a very  large  percentage 
of  the  mortgages  of  corporations  contain  a provision  to 
pay  the  interest  to  the  bondholder  without  any  deduc- 
tion for  Federal  tax,  although  the  Government  is  not 
interested  in  this  feature  one  wTay  or  another. 

In  order  that  the  debtor  corporations  can  keep  this 
covenant  and  at  the  same  time  assume  the  tax  only 
where  an  individual^  income  is  taxable,  it  is  necessary 
for  the  debtor  corporations  to  know  the  class  to  which 
bondholders  belong  and  to  what  extent  they  claim  ex- 
emptions, as  otherwise  the  corporations  might  be  re- 
quired to  pay  a tax  to  the  Government  on  their  entire 
interest,  which  would  be  unjust  and  might  lead  to  pro- 
longed litigation.  Under  these  conditions  the  corpora- 
tions clearly  have  the  right,  before  assuming  the  pay- 


5 


ment  of  the  tax  of  individuals,  to  obtain  from  them  some 
evidence  that  they  are  liable  to  taxation,  and  these 
Ownership  Certificates  can  be  accepted  for  this  purpose. 

The  plan  of  having  Certificates  of  Ownership  accom- 
pany the  coupons  therefore  accomplishes  a two-fold  pur- 
pose. First,  that  of  saving  the  man  with  a small  income 
the  annoyance,  possible  expense  and  delay  of  securing  a 
refund  of  tax  improperly  deducted  when  he  is  not  liable 
to  taxation  and  permitting  every  individual  to  claim 
exemption  up  to  at  least  $3,000  or  $4,000.  Second,  in 
permitting  the  debtor  corporations  to  ascertain  the 
individuals  claiming  exemptions  and  thereby  the  extent 
to  which  the  tax  must  be  assumed  under  the  covenant. 

It  will  be  observed  that  the  certificates  required  by 
the  regulations  are  not  in  the  form  of  affidavits,  as  in 
many  cases  the  expense  of  securing  an  affidavit  would 
be  as  much  as  the  tax  would  amount  to.  Congress  un- 
doubtedly recognized  this  fact  and  the  law  provides  that 
a claim  for  exemption,  in  a written  statement,  is  suffi- 
cient “and  that  thereupon  no  tax  shall  be  withheld  upon 
the  amount  of  such  exemption,”  but  the  penalties  are 
very  severe  for  securing  any  deduction  or  exemption  by 
making  fraudulent  representations  in  these  written 
statements. 

These  Ownership  Certificates  eventually  become  part 
of  the  records  of  the  Government,  hence  the  apparent 
desire  of  the  Government  to  secure  in  every  instance  a 
certificate  with  the  name  and  address  of  the  bondholder. 

Where  an  individual  claims  an  exemption  on  one  of 
the  Ownership  Certificates,  he  fills  in  thereon  the 
amount  of  the  exemption  then  claimed.  To  illustrate, 
if  the  amount  of  coupons  accompanying  a certificate  is 
$100  and  the  individual  claims  exemption,  he  will  fill 
in  $1.00  as  the  amount  of  exemption  claimed  on  that 
particular  certificate.  In  the  same  manner  he  will  con- 
tinue to  claim  exemptions  until  he  has  reached  the  limit 
allowed  by  law.  Should  he  claim  more  exemption  than 
he  is  entitled  to  it  will  be  known  to  the  Government, 
because  no  matter  where  these  certificates  are  taken  up 
by  the  debtor  corporations,  whether  in  New  York,  St. 
Louis  or  New  Orleans,  all  of  his  certificates  will  un- 


6 


doubtedly  eventually  find  their  way  to  the  Collector  of 
Internal  Revenue  for  the  district  in  which  he  resides 
and  be  assembled  under  his  name. 

All  individuals  should  keep  a record  of  the  amount  of 
exemptions  that  they  claim  from  time  to  time,  so  that 
they  will  not  inadvertently  claim  more  than  they  are 
entitled  to  in  any  one  year.  Under  the  law  (Paragraph 
D)  the  amount  of  exemptions  allowed  for  the  taxable 
period  ending  December  31,  1913,  is  only  five-sixths  of 
the  amount  allowed  per  annum. 

We  will  now  follow  these  certificates  through  the 
banks,  to  the  paying  agents  for  the  debtor  corporations. 
We  will  also  first  consider  the  case  where  the  debtor  cor- 
poration has  agreed  to  pay  the  interest  without  deduc- 
tion for  tax.  The  first  certificate  to  come  in  is  say  that 
from  a corporation  which  owns  some  of  the  bonds  of 
the  debtor  corporation.  The  paying  agent  pays  these 
coupons  in  full,  because  under  the  law  no  tax  is  held 
out  against  corporations,  and  places  the  certificate  in 
the  exempt  pile.  The  second  certificate  is  by  an  indi- 
vidual claiming  exemption,  or  by  a non-resident  for- 
eigner who  is  not  subject  to  taxation,  so  his  coupons  are 
paid  in  full  and  the  certificate  placed  in  the  exempt  pile. 
The  third  certificate  is  that  of  a person  who  makes  no 
claim  for  exemption,  but  here  again  the  paying  agent 
pays  the  full  amount  of  the  coupons,  because  in  not 
claiming  the  exemption,  he  is  in  effect  admitting  that  he 
has  taxable  income  and  consequently  the  debtor  corpora- 
tion performs  its  covenant  and  assumes  the  payment  of 
his  tax  by  paying  to  him  the  full  face  value  of  the  cou- 
pon. Occasionally  a Collecting  Agent’s  certificate  will 
come  in,  where  the  owner  of  the  bonds  has  failed  to  at- 
tach an  Ownership  Certificate  to  his  coupons,  but  here 
again  the  debtor  corporation  pays  the  full  face  value  of 
the  coupon  because  in  such  cases  the  first  Collecting 
Bank  withholds  the  tax.  It  will  therefore  be  seen  that 
in  all  cases  where  the  mortgage  contains  this  covenant, 
the  entire  amount  of  the  coupons  is  paid  by  the  debtor 
corporations  as  formerly.  While  in  the  case  of  mort- 
gages with  the  covenant  no  deductions  are  actually 
made  by  the  debtor  corporation,  it  is  nevertheless  re- 


7 


sponsible  to  the  Government  for  the  amount  of  the  tax 
of  taxable  persons,  in  the  same  manner  as  if  it  had  ac- 
tually withheld  the  tax  when  paying  the  coupons.  The 
paying  agent  will  place  the  certificates  of  taxable  indi- 
viduals in  a separate  pile,  and  when  totaled,  the  certifi- 
cates will  show  the  amount  of  tax  deductions  for  taxable 
persons.  Before  the  twentieth  of  the  following  month 
the  debtor  corporation  or  paying  agent  is  obliged  to 
deliver  the  certificates  together  with  a list  to  the  Collec- 
tor of  Internal  Revenue,  and  will  probably  prepare  a 
statement  somewhat  as  follows : 

X.  Y.  Z.  R.  R.  CO. 

General  Mortgage  4%  Bonds  out- 
standing   


Interest  on  same  for  six  months.  . 
Interest  remaining  unpaid  at  time 
of  last  statement 


Interest  now  remaining  unpaid.  . . 


Interest  paid  during  month 

Certificates  of  corporations  and 
other  organizations  herewith 
attached,  representing  coupons 
amounting  to  $200,000 

Certificates  of  individuals  claiming 
exemptions  herewith,  for  interest 
amounting  to  250,000 

$3,300  cash,  representing  amount 
withheld  for  persons  not  claim- 
ing exemptions  on  interest 
amounting  to 330,000 

Certificates  of  Collecting  Banks 
withholding  tax  on  interest 
amounting  to  10,000 

Total  as  above $790,000 


$40,000,000 

800,000 

50.000 

850,000 

60.000 

$790,000 


8 


It  will  be  seen  that  under  the  mortgages  with  the 
covenant,  the  manner  of  paying  the  interest  will  not  be 
changed  from  the  present  methods  and  the  records  kept 
by  the  paying  agent  will  not  require  alteration,  but  the 
paying  agents  will  be  obliged  to  take  as  good  care  of  the 
certificates  as  they  do  of  the  coupons,  and  also  see  that 
the  amounts  stated  on  the  certificates  agree  with  the 
amount  of  coupons  presented  for  payment.  The  banks 
handling  these  coupons  will  also  proceed  as  formerly, 
except  to  see  that  certificates  accompany  the  coupons. 

In  the  mortgages  which  do  not  contain  the  covenant, 
the  proceedings  are  exactly  the  same  as  described  above, 
except  with  respect  to  individuals  not  claiming  exemp- 
tions, in  which  instances  the  paying  agent  will  of  course 
deduct  the  tax  and  pay  the  bondholder  only  ninety- 
nine  cents  on  the  dollar.  In  such  cases  the  paying 
agents  can  open  “Income  Tax  Accounts”  for  each 
issue,  on  their  coupon  ledger,  and  credit  thereto  the 
amounts  so  deducted.  These  accounts  can  be  verified 
from  time  to  time  by  running  up  the  amounts  shown 
on  the  certificates  of  taxable  persons. 

As  a majority  of  the  mortgages  contain  the  covenant, 
and  as  under  the  law  no  tax  is  held  out  on  the  obliga- 
tions of  the  United  States  or  its  possessions,  or  the 
obligations  of  any  State  or  political  subdivision  thereof, 
and  as  doubtless  many  of  the  bonds  which  do  not  con- 
tain the  covenant  are  held  by  corporations,  non-resident 
foreigners,  and  individuals  with  small  incomes,  it  will 
readily  be  seen  that  under  the  plan  adopted,  while  only 
a very  small  amount  of  coupons  will  actually  be  paid  at 
ninety-nine  cents  on  the  dollar,  yet  the  Government  ob- 
tains the  full  tax  to  which  it  is  entitled,  and  in  such  a 
manner  that  it  is  easy  to  verify  the  collection  of  the  total 
tax  on  each  issue  of  bonds,  of  each  corporation.  While 
this  condition  will  last  for  a considerable  period,  the 
amount  of  coupons  to  be  paid  at  ninety-nine  cents  will 
gradually  increase  by  reason  of  the  provision  of  the  law 
casting  doubt  on  the  validity  of  these  tax-free  covenants, 
and  corporate  bonds  hereafter  issued  will  in  many  cases 
not  contain  the  covenant;  such  bonds  will  naturally  be 


9 


treated  the  same  as  is  above  indicated  for  existing  bonds 
not  containing  the  covenant. 

Of  course  any  foreign  paying  agents  of  United  States 
corporations  will  be  obliged  to  proceed  in  exactly  the 
same  manner  as  if  they  were  located  in  the  United 
States. 

Under  the  regulations  the  debtor  corporations  are 
obliged  to  notify  the  Collector  of  Internal  Revenue  of 
their  districts  who  its  paying  agents  are.  The  object 
of  this  provision  is  doubtless  so  that  the  Government 
can  know  where  to  look  for  the  collection  of  the  tax 
upon  the  interest  of  each  corporation. 

Each  debtor  corporation  should  also  immediately 
instruct  its  paying  agent  of  its  wishes  regarding  the 
tax  covenant,  if  contained  in  its  mortgage,  and  supply 
the  agents  with  the  tax  money  where  a taxable  person’s 
tax  is  to  be  assumed. 

FOREIGN  INCOME. 

It  will  be  observed  that  the  tax  on  income  from  for- 
eign securities  is  collected  in  a different  manner  than 
the  tax  on  interest  of  domestic  corporations,  even 
though  the  foreign  corporation  has  a paying  agent  in  the 
United  States.  This  is  apparently  necessary  because 
foreign  coupons  deposited  in  the  United  States  for  col- 
lection might  go  directly  to  the  foreign  country  for  pay- 
ment, instead  of  to  the  paying  agent  in  the  United 
States,  and  consequently  the  Government  would  lose 
taxes  if  the  paying  agent  was  selected  as  the  source 
for  this  class  of  income.  The  Treasury  Department  has 
therefore  apparently  for  this  reason  designated  as  the 
one  to  withhold  the  tax  the  first  person,  or  bank,  pur- 
chasing or  accepting  for  collection  such  coupons,  checks 
or  bills  of  exchange,  and  such  person  or  bank  must  pro- 
cure a license.  Inasmuch  as  no  tax  can  be  held  out 
against  corporations  and  non-resident  foreigners,  and  as 
individuals  also  have  a lawful  right  to  claim  exemptions 
on  income  of  this  character  as  well  as  domestic  interest, 
the  regulations  of  the  Treasury  Department  provide  that 
these  exemptions  may  be  claimed  by  certificates,  the 
same  as  in  the  case  of  interest  of  domestic  corporations, 


10 


except  that  the  person  or  bank  first  purchasing  or  receiv- 
ing these  coupons,  etc.,  shall  retain  the  certificates,  while 
the  coupons,  checks  or  bills  of  exchange  themselves  bear 
the  evidence  to  subsequent  holders  of  whether  they  are 
exempt  from  taxation  or  the  tax  has  been  withheld. 

Foreign  corporations  having  a tax  guarantee  clause 
in  their  mortgage  will  doubtless  raise  the  question  of 
the  manner  in  which  under  this  plan  they  can  carry  out 
their  guarantee.  This  can  be  done  in  the  following  way : 
If  the  coupons  presented  to  the  foreign  corporation,  or 
its  paying  agent  in  the  United  States,  bear  the  endorse- 
ment “Exemption  claimed,”  the  corporation  of  course 
simply  pays  the  face  value  of  the  coupon.  If,  however, 
the  coupon  bears  the  endorsement  “Income  Tax  With- 
held,” it  will  immediately  become  apparent  that  the 
corporation  must  pay  the  coupon  at  one  hundred  and 
one  per  cent., — one  hundred  per  cent,  for  the  coupon 
and  one  per  cent,  for  the  tax  which  is  withheld  by  the 
bank  accepting  the  coupon  for  collection  from  the 
original  owner.  If  coupons  are  purchased  instead  of 
being  taken  for  collection,  this  one  per  cent,  will  nat- 
urally have  to  be  taken  into  consideration  in  the  price 
when  passing  from  one  dealer  to  another. 

EMERGENCY  PROVISION. 

The  regulations  contain  an  emergency  provision  for 
coupons  due  November  1st  which  may  be  in  transit  at 
this  time  without  Ownership  Certificates.  This  permits 
the  bank  presenting  such  coupons  to  the  paying  agent 
to  file  a temporary  certificate  pending  the  receipt  of  the 
regular  Ownership  Certificate  and  thereby  avoiding  the 
necessity  of  returning  the  coupons  to  the  owner  for  the 
regular  certificate,  which  in  many  cases  might  work 
hardship  on  the  owner.  This  provision  permits  the 
return  of  any  tax  improperly  withheld,  upon  the  receipt 
of  the  regular  certificate.  Debtor  corporations  with  the 
tax  covenant  in  their  mortgages  should  explicitly  advise 
their  paying  agents  of  their  wishes  with  respect  to  this 
feature  in  connection  with  emergency  certificate. 


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